The trading risk control practices of energy companies are evolving, but they have some distance to go before they reach the level of risk management practiced by financial institutions, Standard & Poor’s (S&P) said, reporting on its recent review of the risk management policies, infrastructure and methodologies (PIM) of 10 energy trading companies with significant marketing operations with attendant risks.
The risk management policies of most of the companies surveyed are fairly new, S&P said, “ranging from just a few years to less than one year.” Some may have had other policies in effect previously, but “our work in the financial institution group on [trading risk management] suggest that it takes years for companies to develop robust risk control polices that approach best practices, which suggest that steady improvements in the policies of the energy companies are likely to occur.”
In this first pass at an energy risk trading assessment, S&P said it chose companies to review from among merchant power producers, pure financial trading companies, unregulated utilities and oil and gas concerns.
While it identified the companies included in its survey, it did not detail individual company results beyond identifying their current credit ratings: Black Hills Corp., BBB-/Stable/; Constellation Energy Group Inc., BBB+/Negative/A-2; Dynegy, B/Stable/B-2; Edison Mission Energy BB-/Stable/; Exelon Corp., BBB+/Watch Neg/A-2; Mirant Corp., B+/Watch Neg/; NRG Energy Inc., B+/Stable/B-2; Reliant Energy, B/Positive/B-2; Sempra Energy, BBB+/Stable/A-2; and TXU Corp. BB/Watch Neg/.
These companies demonstrated a wide range of risk management programs, although generally those companies doing more trading had a more comprehensive risk infrastructure. S&P found, however, there are some companies “that have a weak risk management practice along with a significant exposure to trading operations, which introduces concern that business strategy and risk management aren’t aligned.”
There was a greater disparity in the risk management practices of the energy companies than there is among financial institutions, “which show significantly less variability across the PIM [risk policies, infrastructure and methodologies] spectrum.”
To make a determination as to a company’s risk policies, S&P analyzed the stature of risk management in the company (does the chief risk officer report to the CEO), its risk appetite, the risk control process and how risk information is disclosed internally and externally.
Regarding a company’s risk infrastructure, S&P analyzed how risk data is captured and managed with the risk architecture and back office functions. In looking at a company’s methodologies, the ratings agency assesses the quality and variety of its valuation techniques and the way in which its models are tested and updated. This includes review of pricing models, methods of evaluating counterparty risks, and the measurement of operational risks.
S&P found energy companies providing very little external information about their risk status, which doesn’t help shareholders and trading partners. “We believe the energy companies must provide effective external disclosure of their risk appetite, control measures, and the potential exposure of ‘tail risks’ that goes beyond the minimum financial reporting standards.”
The ratings agency will be refining its approach to assessing energy company trading risk, expanding it as a component of its overall analysis of power companies with trading operations.
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